What is the impact of Fitch’s downgrade of America’s credit rating on the global financial system?

Ammon – The Fitch Ratings Agency dealt a great shock to the Americans by lowering the country’s credit rating, as the downgrade of the country’s credit rating for only the second time in its history caused a shock in the country and in the entire global financial system. Fitch Ratings has stripped the United States of its first-class sovereign credit rating, repeating a similar action taken by Standard & Poor’s Global Ratings more than a decade ago.

The downgrade came both times, against the backdrop of intense confrontations between politicians over the debt ceiling and borrowing rates. However, history teaches us that the impact of this step on the financial markets may be temporary, but nevertheless, it may provide a pretext for more political confrontations.

1- Why did Fitch downgrade the US rating?

Fitch explained that the decision to lower the credit rating of the United States by one notch to (AA+) came due to the “volatility of the country’s management system,” which “was manifested in the repeated confrontations over the debt ceiling, and the issuance of decisions at the last moments.” This is because every few years the United States, as a result of a self-declared policy, is exposed to the possibility of debt default.

The Act of 1917 established a fixed aggregate limit in US dollars for borrowing (or what is known as the debt ceiling), which could only be increased with the approval of the US Congress and the US President.

As a result, the specter of default continued to haunt the United States during the first half of 2023, after the country came dangerously close to the debt ceiling of approximately $31.4 trillion, and politicians (between the Democratic and Republican parties) delayed reaching a decision until the last moments.

The differences were settled in late May, but they have exacerbated uncertainty about the extent to which US political leaders are committed to abandoning the dangerous political polarization and fulfilling the timely repayment of bonds, in light of the increasing debt burden.

Richard Francis, senior director of sovereign ratings at Fitch Ratings, told that Fitch made its decision to cut the credit rating of the United States due to financial concerns, deteriorating governance and the polarization that was evident in the January 6 tensions.

Francis said that the agency based its decision on reasons including the noticeable deterioration in American governance, which he stressed reduces confidence in the government’s ability to deal with financial and debt issues.

This deterioration, in addition to the increased political polarization in the country, was reflected in the violent events of January 6 that the agency highlighted during its discussions with the Treasury Department.

Fitch had meetings with the Treasury Department prior to the downgrade.

“We highlighted this because it was only a reflection of the deterioration of governance, and this is one of several (causes),” Francis said.

He added, “There is the debt ceiling, there are the events of the sixth of January. And clearly, if you look at the polarization in the two parties … the Democrats have moved to the left and the Republicans have moved more to the right, which has basically weakened the center somewhat.”

2 – What does an AA+ rating mean?

The AA+ rating is just one notch below AAA, which means that the United States no longer has what Fitch defines as the “highest credit quality”. While Fitch notes that the AA rating indicates a “very low expectation of risk of default”, this is a downgrade from the “lowest expectation of risk of default” for AAA-rated borrowers.

By the same token, the top rating is only assigned to cases of “exceptionally strong ability” to meet financial commitments, while AA credit levels indicate “extremely strong ability”, according to Fitch Ratings.

Globally, Fitch is the smallest of the “Big Three” rating agencies, which also include Moody’s Investors Service and Standard & Poor’s.

3 – How are government bonds classified?

Credit rating agencies rate the financial strength of bond issuers, including governments, and give them credit scores that determine their ability to meet debt payments.

Investors usually rely on these credit ratings when deciding to buy any bonds, and these ratings can also strongly affect the amount of returns that borrowers pay to raise funds in the capital markets.

However, US bond yields are low thanks to demand for both the dollar (the global reserve currency) and US Treasury bonds which are seen as the global benchmark for risk-free assets.

4 – How will the markets be affected?

After Standard & Poor’s downgraded the US government’s credit rating in 2011, concerns arose about the strength of the US economy, at a time when Europe was going through a sovereign debt crisis. However, this move had a limited impact in the long run, as investors flocked to US assets again, and US government debt yields declined by the end of 2011.

And the US budget deficit jumped to $421 billion in 3 months..thanks in part to the fact that the US economy maintained its momentum, while at the same time the European Union was struggling to preserve the union based on the use of the single currency. And now the scene is repeating again, as financial markets feel fears about the US economy, but this time the focus is on the monetary tightening cycle and the Federal Reserve has raised interest rates at the strongest pace in decades to curb inflation.

As a result, it is likely that the Fed’s steps and the fall in US interest rates will be much more influential than a downgrade by Fitch Ratings. On the other hand, Moody’s still has the US at its highest rating, which is even more important now that Fitch’s rating has been downgraded.

5 – What does this mean for other classifications?

The number of countries at the top of the ranking of creditworthiness is dwindling, and Australia, Germany, Singapore and Switzerland still have the highest ratings from all three major rating agencies, according to data compiled by Bloomberg. Fitch also assigned Canada an AA+ rating.

As for China – the second largest economy in the world after the United States – it has an (A+) rating from Fitch, which is three notches lower than America. The classification of a country may be based on the highest rating obtained by companies in that country, not its overall rating.

The list of companies that received (AAA) ratings from any one of the three major rating institutions has also shrunk, but this list still includes some American companies, such as Microsoft and Johnson & Johnson.

bloomberg